Wild West of Investing: Cryptocurrencies
Every time something new enters the financial world there is always this uncertainty that comes along with it. What is it? Who built it? Can I trust it? When banks first came into the world they were considered the ‘wild west’ because no system was in place before to hold a pool of people’s funds, not everyone trusted the system. Fast track to today and there is now a new ‘wild west’ of finance, Cryptocurrencies. Over the past 18 months you would’ve heard about Bitcoin and for most of you, don’t know what it is or you might want to jump on the bandwagon. In this blog I’ll run you through the basics of Cryptocurrencies and share my views on this new wild west.
What is a Cryptocurrency?
- It is a system of storing and creating currency (token or unit of currency) to allow people to buy and sell to keep currency outside the financial system. It stores value because you exchange it for other assets.
- In the late 90’s there have been numerous attempts to develop digital money, but they all failed. In early 2009, Satoshi Nakamoto released a new electronic cash system that uses peer-to-peer network, decentralized with no central authority, known as Bitcoin.
Why was Bitcoin created?
- Double-spending is the result of successfully spending some money more than once, users of Bitcoin prevent themselves from double-spending by using its blockchain technology.
- Blockchain is a non-corruptible digital ledger (collection of financial accounts) of economic transactions and this new technology will change the way of record keeping across nearly every industry.
How can someone buy and sell Cryptocurrencies?
- A cryptocurrency is released in an ICO (Initial Coin Offering), it is impossible to say whether an ICO will be successful because there is no prospectus, no financial services legislation, no control over it.
- Cryptocurrency markets never open or close, they trade 24/7 365 days a year, unlike equity markets.
- You need a broker to execute the trade and an exchange. The exchange is where you buy and sell Cryptocurrency through, similar buying and selling a stock through a stock exchange (ASX for example).
- When you own a Cryptocurrency, you need to have a ‘digital wallet’ (like chess on the share system). It is a piece of hardware that keeps your cryptocurrency in a given place that identifies who owns it and how to access it.
- The exchange must support the cryptocurrency, some exchanges won’t accept certain cryptocurrencies, so you may need to hold other wallets to be able to obtain these types of cryptocurrencies.
Why are cryptocurrencies so volatile?
There are several contributing factors that have contributed to the price swings in the brief history of Bitcoin including some of these runs:
- May 31 – June 8, 2011: Increase 239%
- June 8-12, 2011: Declined 51%
- August 7 – 9, 2011: Increase 82%
- January 15 – February 16, 2012: Declined 40%
- August 5 – 17, 2012: Increase 24%
- August 16-19, 2012: Declined 41%
- March 31 – April 9, 2013: Increase 147%
- April 9-16, 2013: Decrease 70%
- November 20 – 29, 2013: Increase 108%
- May 19 – June 3, 2014: Decrease 50%
- Nov 24 – December 11, 2015: Increase 42%
- June 19 – August 2, 2016: Decreased 28%
- November 12 – December 16, 2017: Increase 230%
- December 17 2017 – February 6 2018: Declined 61%
Among the reasons are:
- Cryptos a largely not being used for its sole purpose of being a currency exchange, they are being used for wild investor speculation. Jordan Belfort expresses the volatility as a major “pump and dump” price manipulation, many traders of the coin buy and sell regarding what they read and watch online. “bulls make money, bears make money, pigs get slaughter”- J.Belfort.
- Whenever there is a surge in a cryptocurrency there is a lot of FOMO (fear of missing out) that goes along with it, which ultimately further drives the price of coins up.
- Government crackdown on banning cryptocurrency trading, which has happened in China and South Korea, spooks investor confidence and drives down the price of bitcoin. However there are countries that are embracing the use of cryptocurrencies, for example Japan has made Bitcoin a legal form of payment.
- Facebook has recently placed a ban on advertisement promoting cryptocurrency products, written in a blog post by Facebook “We’ve created a new policy that prohibits ads that promote financial products and services that are frequently associated with misleading or deceptive promotional practices, such as binary options, initial coin offerings and cryptocurrency,”
- There is also a security threat to owning cryptos, very recently Coincheck which is one of the largest cryptocurrency exchanges in Japan was hacked that resulted in a loss of over $500 million, an event like this crumbles investor confidence of cryptocurrencies and drives down price.
Should you buy into Cryptocurrencies right now?
- There is a finite amount of Bitcoin in the world, currently 14 million Bitcoin are in circulation currency, but by 2140 there will only be 21 million in existence.
- Investors should understand the difference between investing in equities (shares) and other financial assets (bonds, derivatives etc) compared to investing in bitcoin. There is no intrinsic value from buying a cryptocurrency and as a result there is no fundamental based valuation analysis, merely only investor speculation which is predominantly why prices are so volatile.
- Every investor should understand how much risk they are willing to hold with their investments. I would consult with your Financial Advisor about the implications a holding of cryptocurrency would have on your portfolio, especially if you are a risk-averse investor.
- Like any investment you must understand what you’re buying and understand its fundamental purpose. Holding a cryptocurrency will be a very long and volatile ride and you must believe that it is going to be a viable alternative to our current and well established currency system.
If you wish to discuss these ideas and concepts, feel free to leave a question in the comments or send an email to me directly at email@example.com and I will happily reply.
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